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The number of M&A transactions has gradually increased again over the course of the year, which is also having an impact on the market for warranty and indemnity (W&I) insurance. This is also becoming increasingly relevant in securing the acquisition of insolvent targets – in the form of fully or partially synthetic coverage.
Going Public: The M&A market seems to be gradually recovering, and the number of transactions is increasing. Do you expect the W&I market, which hedges the transaction risks of such deals, to harden accordingly?
Robert Engels: The soft market may have reached its lowest point by the end of this year. However, due to the positive market development and the risk appetite of some insurers, we do not expect providers to adjust policy conditions to the detriment of policyholders. Only a slight increase in premiums is to be expected.
Janin Kauffman: In addition, there are currently many providers active and more insurers have entered the market in recent months. They have brought additional capacity to the market. These factors have further increased the already strong competition.
Currently, a wave of insolvencies continues to sweep across Germany and is now even affecting insurers, most recently the Luxembourg life insurer FWU Life Insurance Lux. To what extent do such major insolvencies affect the W&I market?
Engels: We need to look at the role of bankruptcies from two perspectives. First, they have no direct impact on the W&I market. However, if M&A activity does not continue to increase as expected, there could be consolidation among insurers. Second, W&I insurance is a suitable tool to insure sales from insolvency, so-called distressed deals. Against this background, the W&I market is well prepared and ready to offer solutions.
To what extent is W&I insurance a suitable tool for this?
Kaufmann: It is possible to take out partially or fully synthetic W&I insurance. It should be noted that these forms are not only used for distressed deals. Another suitable application is in the real estate sector, when investors have transferred the management of their portfolio to an administrator. The existence of a large consortium of sellers is also a possible application scenario, especially for a fully synthetic W&I solution.
What is the difference to the classic W&I policy?
Engels: Conventional W&I insurance protects the buyer against breaches of warranty or false statements by the seller within the framework of a warranty catalog negotiated with the seller. With fully synthetic coverage, a fictitious warranty catalog is agreed between the buyer and the insurer instead. This is necessary if the seller cannot provide reliable guarantees for the target, but the buyer still wants to insure against the risks. The warranty catalog is usually based on a standardized catalog. It is therefore neither particularly buyer- nor seller-friendly and is tailored to the individual case, also depending on the industry. If the guarantees contained in the policy prove to be false, the insurer will cover the damage.
Kaufmann: With semi-synthetic coverage, however, the catalog of guarantees already in place between buyer and seller is expanded in some places by specific guarantees in the policy, often through a synthetic tax exemption. In addition, a semi-synthetic policy includes, for example, an expanded definition of damage, the elimination of knowledge qualifications from the purchase contract or an expanded definition of the seller’s knowledge. These agreements have already become standard in W&I policies and we see them in virtually every policy placed. Both options for (semi-)synthetic extensions have the advantage that they simplify negotiations between buyer and seller.
What should be taken into account when taking out a policy?
Engels: If insurers offer this type of cover, they waive any right of recourse against the seller, which is not insignificant. Normally, with a regular W&I policy, the insurer has the option of reclaiming the damages from the seller in the event of fraudulent deception by the seller. This right does not apply, particularly with the fully synthetic variant. This means that insurers weigh up when it makes sense to offer this type of cover and when it does not.
And how does that work?
Kaufmann: This is where due diligence, the careful examination of the target, comes into play, which is carried out before every transaction anyway. It is even more important with synthetic W&I cover, as the insurer does not receive any further form of confirmation. As a prerequisite, a comprehensible justification must be given as to why the seller cannot provide any guarantees. In addition, the seller may have to prepare annexes to the purchase agreement (so-called disclosures) in accordance with the insurer’s specifications shortly before the notarization. Buyers and insurers are therefore dependent on the active participation of the seller in the disclosure process.
A certain residual risk always remains. This raises the question of the type and frequency of typical W&I losses.
Engels: It is difficult to make concrete statements in this regard. It is practically a well-kept secret, because the data on damage is simply too thin – many insurers do not disclose their damage. However, studies by WTW and the disclosures of a few insurance companies show that damage in the financial and tax area is the most common. This can be, for example, errors in tax returns, annual accounts or accounting. The fact that this type of damage occurs again and again is also due to the fact that we have regular tax audits in the DACH region.
How do you think the M&A and related insurance market will develop?
Kaufmann: It is very impressive how the market is constantly moving. It remains to be seen how the transaction figures and thus the insurance conditions develop.
Engels: This is particularly true with regard to the scope of cover. As mentioned at the beginning, an increase in premiums would be completely normal and to be expected. The big question is whether the improved cover conditions will be maintained. We assume this will be the case.
Ms. Kauffmann, Mr. Engels, thank you very much for the interview!
The interview was conducted by Stefan Preuß.
ABOUT THE PEOPLE
Robert Engels leads the M&A advisory team in the Corporate Risk & Broking division at WTW for Germany, Switzerland and Austria. The team specializes in the areas of transaction insurance solutions and insurance due diligence. Before joining WTW in 2019, Engels led the M&A advisory teams at two international insurance brokers in the DACH region.
Janin Kauffman is a fully qualified lawyer for the Corporate Risk & Broking division at WTW for Germany, Switzerland and Austria. There she has headed the transaction insurance department within M&A since 2018. Before working as a consultant, she gained almost five years of experience as an M&A underwriter for European corporate and private equity transactions at various insurers.
www.wtwco.com/de-de
Stefan Preuss
Stefan Preuss has been working as an editor in the capital markets environment for more than 25 years. The trained daily newspaper editor also gained experience as an investor relations manager. He is a permanent member of the editorial team at GoingPublic Media AG, focusing on IPOs, asset investments and succession solutions. As editor-in-chief, he oversees the annual special editions “Employee Participation” and “M&A Insurance”.
